The U.S. Court of Appeals for the First Circuit yesterday affirmed another conviction in a pair of appeals arising from insider-trading prosecutions.  The decision in United States v. McPhail confirms that, under current First Circuit precedent, a tipper of inside information can receive “personal benefits” based on expectations of a free dinner, wine, and a massage parlor, on “kickbacks” from a tippee-friend’s trades, and on his tippee-friends’ “general gratitude for his largesse.”

Factual Background

The McPhail case involved allegedly material, nonpublic information that a corporate executive had provided to McPhail.  The executive and McPhail had allegedly had a close relationship and a history, pattern, and practice of sharing professional and personal confidences so that the executive purportedly had reason to believe that McPhail would not disclose the confidences.  McPhail did not trade on the information from the executive, but he allegedly told several of his “golfing buddies” (including Parigian) about it, and the tippees traded on it.

The Government indicted McPhail (and Parigian) under the misappropriation theory of insider trading, contending that McPhail had breached a duty of trust and confidence to the executive by misappropriating the confidential information disclosed to him and relaying it to Parigian and others in exchange for personal benefits.  McPhail was convicted, and he appealed.  Parigian conditionally pled guilty, but preserved his right to challenge the sufficiency of the indictment.

The First Circuit affirmed Parigian’s conviction in May 2016.  And the First Circuit affirmed McPhail’s conviction yesterday.

First Circuit’s Decision

Duty of Trust and Confidence

The court first held that, based on the evidence at trial, the jury could have concluded that McPhail and the executive had shared a relationship of trust and confidence under SEC Rule 10b5-2(b)(2), which provides that a “duty of trust or confidence” exists between the communicator and the recipient of material, nonpublic information when the communicator and the recipient “have a history, pattern, or practice of sharing confidences, such that the recipient of the information knows or reasonably should have known that the [communicator] expects that the recipient will maintain [the information’s] confidentiality.”

The evidence showed that McPhail and the executive were “frequent golf partners” and “close friends,” who traveled on vacation and attended sporting events together, “communicated daily and saw one another several times a week.”  The executive had loaned money to McPhail “to pay off a gambling debt that McPhail was trying to hide from his wife,” and he later forgave the debt entirely.  The executive’s wife also “asked McPhail to mediate a marital argument that threatened [the executive’s] marriage.”

The court noted that McPhail had not challenged the SEC’s statutory authority to promulgate the rule, so the court “assume[d] without deciding that Rule 10b5-2(b)(2) constitutes a valid exercise of administrative rulemaking.”

Mens Rea Requirement

McPhail took issue on appeal with the jury instructions’ use of Rule 10b5-2(b)(2)’s “knew or should have known” language.  He contended that the District Court should have required the jury to find that he had “known” he was breaching his duty to the executive, not merely that he “‘knew or reasonably should have known’ that the [executive] expected him to keep the information secret.”

The First Circuit held that its Parigian decision “suggests that the instruction was likely error.”  However, the court concluded that McPhail might have waived his challenge to the jury charge and that, in any event, he had forfeited it, “triggering a review for only plain error.”

The First Circuit did not find plain error in the instructions.  Rather, the court observed that “we have not actually held that [such an instruction] is error, and at least two circuit courts have expressly blessed the ‘knew or reasonably should have known’ standard.”  The court cited decisions from the Sixth and Seventh Circuits.

Receipt of Personal Benefits

The First Circuit also held that the evidence had sufficiently established that McPhail had received personal benefits in exchange for tipping the material, nonpublic information to Parigian and others.  As in the Parigian case, the court assumed that the personal-benefit requirement applies in misappropriation cases, not only in classical insider-trading cases (where an insider trades on confidential corporate information or discloses it in exchange for a personal benefit).  And as in Parigian, the court acknowledged that “the nature of the personal benefit requirement in insider trading cases is the source of some inter-circuit tension likely to be resolved by the Supreme Court in its next term.”

However, the court held that, under current First Circuit precedent, the personal-benefit requirement can be “satisfied by benefits as thin as ‘reconciliation with [a] friend’ and the maintenance of ‘a useful networking contact,’ . . . or ‘the mere giving of a gift to a relative or friend.’”  Those standards were met in this case based on the three types of personal benefits identified at trial:  “McPhail’s expectations that he would receive a free dinner, wine, and a massage parlor visit from the beneficiaries” of his tips; his receipt of “a $3,000 ‘kickback’” from a tippee-friend who had obtained nearly $200,000 in trading profits; and the benefit of the tippee “group’s general gratitude for his largesse.”  “Jurors were told:  ‘It makes him one of the guys, they’re all kind of impressed.’”

What the Court Did Not Decide

As noted above, the McPhail decision did not decide a number of potentially important issues.

First, the court did not decide whether the SEC had statutory authority to promulgate Rule 10b5-2(b).  Other courts, such as the Third Circuit, have upheld the rule.

Second, because of the waiver/forfeiture analysis, the court did not decide the validity of a “knew or should have known” standard for mens rea in a criminal case.  However, the court suggested, as it had done in Parigian, that such a standard is inappropriate – although the First Circuit acknowledged that other circuits have concluded otherwise.

Third, the court did not decide whether a tipper must have received a personal benefit in a misappropriation case.  The court simply assumed that the requirement applies.  Other courts, including the Second Circuit, have said that the requirement applies in both misappropriation and classical insider-trading cases.

Fourth, as in Parigian, the court declined to enter the debate involving the Second and Ninth Circuits’ potentially conflicting constructions of the “personal benefit” requirement.  All eyes will be on the Supreme Court next term when it considers the Ninth Circuit’s decision in United States v. Salman.

We previously blogged about the McPhail and Parigian cases here and here.

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Photo of Jonathan Richman Jonathan Richman

Jonathan Richman represents a variety of companies in securities class actions, shareholder derivative actions, internal investigations, SEC investigations, corporate governance, insider trading, D&O insurance and related matters. Many of those matters involve international elements, including representations of non-U.S. issuers in U.S. litigation and…

Jonathan Richman represents a variety of companies in securities class actions, shareholder derivative actions, internal investigations, SEC investigations, corporate governance, insider trading, D&O insurance and related matters. Many of those matters involve international elements, including representations of non-U.S. issuers in U.S. litigation and in landmark non-U.S. collective settlements under Dutch law in the Netherlands. Jonathan’s clients have included Hewlett Packard, Royal Dutch/Shell, Zurich Insurance Group, Halliburton, Waste Management, and Bed Bath & Beyond.

Jonathan writes extensively on topics ranging from securities and insider-trading law, corporate governance and fiduciary issues to non-U.S. law on collective actions. His articles have been published in major legal publications.

Jonathan is the past co-head of the Firm’s Securities Litigation Group.

Class Action and SEC Enforcement Experience

  • Royal Dutch/Shell
  • Global Crossing
  • Waste Management
  • Zurich Insurance Group
  • Vestas Wind Systems A/S (class action only)
  • JBS S.A. (class action only)
  • Henry Schein, Inc. (class action only)
  • YRC Worldwide Inc. (class action only)
  • Bed Bath & Beyond Inc. (class action only)
  • Roka Bioscience, Inc. (class action only)
  • Fifth Street (class action only)
  • Vida Longevity Fund (class action only)
  • Former CEO of Lumber Liquidators (class action only)
  • Individual defendant in Third Avenue securities class actions
  • American General (class action only)
  • Metropolitan Life (class action only)
  • New York Life (class action only)
  • Leucadia/Jefferies merger litigation (class action only)
  • Realty Income/American Realty merger litigation (class action only)
  • ARCP/ARCT III merger litigation (class action only)
  • Aberdeen/Artio merger litigation (class action only)
  • PhotoMedex/LCA-Vision merger litigation (class action only)
  • RCS Capital/Summit Financial merger litigation (class action only)
  • First American/First Advantage merger litigation (class action only)
  • SEC inquiry involving CMBS servicing
  • SEC inquiry involving issuer’s confidentiality notice for internal investigations
  • Various SEC, CFTC, and FINRA inquiries involving trading issues

Shareholder Derivative Litigation

  • Hewlett-Packard
  • Royal Dutch/Shell
  • Brocade Communications Systems, Inc.
  • Halliburton Company
  • Waste Management, Inc.
  • Henry Schein, Inc.
  • YRC Worldwide Inc.
  • Bed Bath & Beyond Inc.
  • Fifth Street
  • Vida Longevity Fund
  • Former CEO of Lumber Liquidators
  • Individual defendant in Third Avenue derivative litigation

Department of Justice Proceedings

  • Royal Dutch/Shell
  • Global Crossing
  • Property and casualty insurers

Miscellaneous

  • Advising outside directors of for-profit educational institution on litigation and regulatory investigations
  • Providing advice and training sessions for clients on insider-trading issues
  • Representing Financial Oversight and Management Board for Puerto Rico in pending litigation arising from Puerto Rico bankruptcy

Publications

  • Author, “Court Preliminarily Enjoins Florida’s ‘Stop Woke Act,’” National Law Review (Aug. 22, 2022)
  • Author, “Blockchain Meets Morrison:  Court Rejects Blockchain Class Settlement Because of Concerns About Adequacy of Representation,” National Law Review (Aug. 16, 2022)
  • Author, “Delaware Supreme Court Allows Use of ‘Reliable’ Hearsay to Support Books-and-Records Demand,” National Law Review (July 20, 2022)
  • Author, “Divided Delaware Supreme Court Decision Highlights Issues About Director Independence in Derivative Actions,” National Law Review (June 30, 2022)
  • Author, “Second Circuit Reverses Dismissal of Securities Claim Alleging Failure to Disclose SEC Investigation,” National Law Review (May 25, 2022)
  • Author, “Ninth Circuit Upholds Delaware-Forum Bylaw That Precludes Assertion of Federal Proxy Claim,” National Law Review (May 13, 2022)
  • Co-author, “SEC Defeats Motion to Dismiss Insider Trading Complaint Alleging Novel ‘Shadow Trading’ Theory, The Corporate Lawyer, vol. 59, no. 3 (Feb. 2022), at 1
  • Co-author, “Seventh Circuit Reverses Dismissal of Derivative Action Based on Forum Clause as Applied to Federal Claim,” National Law Review (Jan. 21, 2022)
  • Author, “California Federal Court Holds U.S. Securities Laws Inapplicable to Unsponsored, Unlisted ADR Transaction Preceded by Purchase of Common Stock Outside the U.S.,” National Law Review (Jan. 10, 2022)
  • Co-author, “SEC Pursues ‘Shadow Trading’ Insider Trading Case,” Corporate Governance Advisor, vo. 29, no. 6 (Nov./Dec. 2021), at 29
  • Co-author, “SEC Investor Advisory Committee Considers Recommendations to Tighten Rules for Insiders’ Trading Plans,” National Law Review (Sept. 7, 2021)
  • Author, “Second Circuit Holds that Accurately Reported Financial Statements Are Not Actionable and that Materiality Has a Half-Life,” National Law Review (Aug. 27, 2021)
  • Author, “First Circuit Adopts Prevailing Standard for Applicability of Federal Securities Laws to Foreign Investors, But Rejects Second Circuit’s Narrower Test,” National Law Review (May 11, 2021)
  • Author, “Second Circuit Upholds Insider Trading Conviction, Finding Sufficient Confidentiality Duty and Personal Benefit,” National Law Review (Apr. 7, 2021)
  • Co-author, “Second Circuit Reaffirms that Federal Securities Laws Do Not Apply to Predominantly Foreign Transactions,” National Law Review (Jan. 26, 2021)
  • Author, “Corporate Scienter Requires Link Between Employees with Knowledge and the Alleged Misstatements,” National Law Review (May 26, 2020)
  • Author, “Delaware Supreme Court Rules that Corporate Charters Can Require Litigation of Federal Securities Act Claims in Federal Court,” National Law Review (Mar. 18, 2020)
  • Author, “California Federal Court Holds that U.S. Securities Laws Apply to Unsponsored, Unlisted ADRs,” National Law Review (Jan. 30, 2020)
  • Author, “Second Circuit Holds that a ‘Personal Benefit’ Is Not Required for Insider Trading Under Criminal Securities Statute,” National Law Review (Jan. 2, 2020)
  • Co-author, “When Passive Investors Drift into Activist Status,” CCR Corp. Deal Lawyers (Nov.-Dec. 2019)
  • Author, “Delaware Supreme Court Rejects Presumption of Confidentiality for Books-and-Records Productions,” National Law Review (Aug. 8, 2019)
  • Author, “Supreme Court Raises Questions About Private Rights of Action Under § 14 of Securities Exchange Act,” National Law Review (Apr. 24, 2019)
  • Author, “Second Circuit Rejects Securities Claims Based on Generic Statements About Ethics and Compliance,” Securities Reform Act Litigation Reporter, vol. 47, no. 1 (April 2019), at 54
  • Author,” Supreme Court Holds that Persons Who Do Not ‘Make’ Misstatements Can Nevertheless Be Liable for Other Securities-Fraud Violations,” National Law Review (Mar. 29, 2019)
  • Author, “The importance of documenting corporate actions: Delaware Supreme Court requires production of emails in books-and-records request,” Westlaw Journal Mergers & Acquisitions (Feb. 2019)
  • Author, “First Appellate Decision Holds that SEC Can Bring Extraterritorial Enforcement Action Based on Conduct or Effects in United States,” National Law Review (Jan. 24, 2019)
  • Author, “Insider Trading for Dummies: Judge Rakoff Tries to Simplify the Law,” National Law Review (Dec. 10, 2018)
  • Co-author, “Fortis Case Confirms Viability of Dutch Settlement Law,” Law360 (July 27, 2018) (with Professor Ianika Tzankova)
  • Author, “Second Circuit Again Holds That Tipper/Tippee Liability Can Arise from a Gift of Inside Information Even Without a Close Personal Relationship,” National Law Review (June 29, 2018)
  • Author, “Supreme Court Rules That Federal Courts Are Not Bound to Give Conclusive Effect to Foreign Governments’ Statements About Their Laws,” National Law Review (June 14, 2018)
  • Author, “Supreme Court Prohibits Stacking of Successive Class Actions Beyond Limitations Period,” National Law Review (June 14, 2018)
  • Author, “Supreme Court Rules That State Courts Can Adjudicate Class Actions Under the Securities Act of 1933,” Securities Arbitration Commentator (April 11, 2018)
  • Author, “Fourth Circuit Upholds Disclosure of Government Subpoena as Evidence of Loss Causation,” National Law Review (Feb. 24, 2018)
  • Author, “Revisiting Preclusion Principles in Derivative Actions,” Law360 (July 28, 2017)
  • Author, “Second Circuit Requires Increased Scrutiny of Securities Class Actions Involving Off-Exchange Transactions,” National Law Review (July 8, 2017)
  • Author, “Dutch Court Denies Approval of Collective Settlement Unless Changes Are Made as to Allocation of Compensation and Fees,” National Law Review (June 19, 2017)
  • Author, “Utah Court Bites Bullet with Dodd-Frank Jurisdiction Ruling,” Law360 (Apr. 13, 2017)
  • Author, “Non-Use Agreement Need Not Precede Disclosure of Confidential Information,” National Law Review (March 21, 2017)
  • Author, “Watch the Napkin: First Circuit Affirms Insider-Trading Conviction,” National Law Review (Feb. 28, 2017)
  • Author, “Dueling Shareholder Class Actions Could Raise Due Process Issues,” Law360 (Jan. 30, 2017)
  • Author, “Supreme Court Reaffirms Personal-Benefit Requirement for Insider Trading,” WestLaw Journal: Securities Litigation & Regulation and WestLaw Journal: White-Collar Crime (Dec. 22, 2016)
  • Author, “Rakoff Addresses Tippee Liability in SEC v. Payton,” Law360 (Dec. 2, 2016)
  • Author, “Dutch Collective Actions vs. Collective Settlements,” National Law Review (Oct. 18, 2016)
  • Author, “Judgment Recognition and the Reach of US Securities Laws,” Law360 (Oct. 3, 2016)
  • Author, “Executives Face SOX Disgorgement Uncertainty After Jensen,” Law360 (Sept. 8, 2016)
  • Author, “Wine, Steak and a Taste of the ‘Personal Benefit’ Tension,” Law360 (June 6, 2016)
  • Author, “Proskauer Explains Supreme Court’s Clarification of Jurisdiction Under Securities Exchange Act,” The CLS Blue Sky Blog (May 24, 2016)
  • Author, “Second Circuit Reinforces Liability Standard in Securities Cases Based on Statements of Opinion,” Business Law Today (Mar. 2016)
  • Author, “The Netherlands Returns as a Collective Settlement Forum,” Law360 (Mar. 15, 2016)
  • Author, “How Morrison v. Australia Bank Was Applied in Petrobras,” Law360 (Feb. 16, 2016)
  • Author, “New York Court Certifies Classes in Petrobras Securities Litigation,” National Law Review (Feb. 3, 2016)
  • Author, “Delaware Court of Chancery Rejects Another Disclosure-Only M&A Settlement and Warns of ‘Increasingly Vigilant’ Scrutiny,” National Law Review (Jan. 25, 2016)
  • Author, “What To Expect from High Court’s New Insider Trading Case,” Law360 (Jan. 19, 2016)
  • Author, “Second Circuit Upholds Common-Interest Privilege for Borrower’s Sharing of Legal Advice with Consortium of Lenders,” Transaction Advisors (Dec. 2015)
  • Author, “What Jarkesy Means for SEC Admin Court Challenges,” Law360 (Sept. 30, 2015)
  • Author, “A Farewell to Alms? Peppercorn Settlements of M&A Litigation,” National Law Review (Sept. 21, 2015)
  • Author, “Seventh Circuit Rejects Court Challenge to Pending SEC Administrative Proceeding,” com (Aug. 27, 2015)
  • Author, “9th Circuit Rebuffs Newman,” Law360 (July 8, 2015)
  • Author, “Proskauer Discusses Supreme Court’s Omnicare Decision, Clarifying Liability for Statements of Opinion in Registration Statements,” The CLS Blue Sky Blog (Mar. 24, 2015)
  • Author, “U.S. Appeals Court Rejects Bright-Line Test for Extraterritorial Reach of U.S. Securities Laws,” Bloomberg BNA World Securities Law Report, vol. 20, no. 9 (Sept. 2014)
  • Author, “Whistleblower Anti-Retaliation Provision Does Not Apply Outside the U.S.,” Westlaw Journal Securities Litigation & Regulation, vol. 20, issue 9 (Sept. 4, 2014)
  • Author, “So Much for Bright-Line Tests on Extraterritorial Reach of US Securities Laws?,” Harvard Law School Forum on Corporate Governance and Financial Regulation (Sept. 2, 2014)
  • Co-author, “Defending Directors: Cram Sheet,” Wolters Kluwer Law & Business (October 23, 2012)
  • Author, “Delaware Chancery Court Issues Decision on Collateral Estoppel in Derivative Suits,” Westlaw Journal Delaware Corporate, vol. 26, issue 25 (June 25, 2012)
  • Author, “SEC Issues Report on Extraterritorial Reach of U.S. Securities Laws,” VCExperts on-line publication (June 2012)
  • Co-author, “Fraud? Foreign Purchase? Forget It! ‘Foreign-Cubed’ and Other Foreign-Issuer Cases After Morrison,” of Secs. & Commodities Reg., vol. 44, no. 4 (Feb. 23, 2011)
  • Author, “Supreme Court Clarifies Statute of Limitations in Securities-Fraud Actions,” Derivatives Financial Prods. Rpt., 11, no. 10, at 23 (June 2010)
  • Author, “Transnational Class Actions and Judgment Recognition,” Class Action Litigation Report (June 25, 2010)
  • Co-author, “Pushing the Limits of U.S. Securities Laws: ‘Foreign-Cubed’ (‘F-Cubed’) Cases,” 42 SRLR 10 (March 8, 2010)
  • Co-author, “Assignees Have Discovery Obligations When Asserting Assignors’ Claims,” Journal of Payment Systems Law (June/July 2005)
  • “Punitive Damages: Past, Present and Future,” International Commercial Litigation (July/August 1995)
  • Co-author and editor, Takeovers: Attack and Survival (1987)
  • Co-author, “New Life for State Takeover Statutes?,” New York Law Journal (July 27, 1987)
  • Co-author, “Damages in Defamation Actions,” Damages in Tort Actions (1985)
  • “Facial Adjudication of Disciplinary Provisions in Union Constitutions,” Yale Law Journal (1981)

Presentations

  • Practising Law Institute: “ESG 2022: What It Means for Boards, Management, and Counsel” (June 1, 2022) (full-day program; program co-chair and panel chair)
  • Practising Law Institute: “ESG 2021: What It Means for Boards, Management, and Counsel” (webcast, June 24, 2021) (full-day program; program co-chair and panel chair)
  • Practising Law Institute: “ESG 2020: What It Means for Boards, Management, and Counsel) (webcast, July 24, 2020) (full-day program; program co-chair and panel chair)
  • Practising Law Institute: “ESG and Promoting Corporate Sustainability” (New York, June 25, 2019) (full-day program; program chair and panel chair)
  • The Mason Judicial Education Program, Symposium for Judges: Securities Class Action Litigation (Arlington, VA, May 5, 2019)
  • The Mason Judicial Education Program, Symposium for Judges: The Economics of Corporate & Securities Law (San Diego, April 12-14, 2018)
  • ABA Section of Litigation: “Recent Developments in Securities Class Actions” (webinar, May 11, 2017)
  • Professional Liability Underwriters Society D&O Symposium: “Behaving Badly: The Non-U.S. Corporate Scandal Wave” (New York, February 9, 2017)
  • New York State Bar Association International Section: “Hot Topics in Cross-Border Securities Litigation” (São Paulo, October 16, 2015)
  • Proskauer Hedge-Fund Breakfast Seminar on Insider Trading (New York, Feb. 5, 2015)
  • CLE International’s 9th Annual Class Action Conference: “Collective Proceedings Abroad: Evolving Approaches & Attitudes” (Washington, D.C., October 2013)
  • Practising Law Institute: “Handling a Securities Case: From Investigation to Trial and Everything in Between” (New York, April 2012)
  • Institutional Investor Educational Foundation: Corporate Governance Roundtable Forum (New York, December 2011)
  • Institutional Investor Educational Foundation Amsterdam Roundtable: “The Netherlands and the Future of European Securities Litigation” (The Hague, September 2011)
  • Summer Institute on Law & Government, American Univ. Washington College of Law: “Securities Class Actions – An Update” (Washington, D.C., June 2010)
  • ABA Section on Litigation Annual Conference: “Global Class Actions: Lasting Peace or Ticking Time Bombs?” (New York, April 2010)